ΑΡΘΡΑΟΙΚΟΝΟΜΙΑ

05.05.2011

Γιάννος Παπαντωνίου: Policy prescriptions for curing eurozonitis

The Greek debt crisis and other eurozone countries' response to it have highlighted the vulnerability of the European single currency. Yannos Papantoniou, a former Greek Finance Minister, sets out the steps now needed.

The global financial crisis and eurozone’s sovereign debt crisis have highlighted a fundamental truth of economics; large imbalances in either the real economy or the financial sector, or both, are bound to disrupt the functioning of economic systems. The question now is how best to cure "eurozonitis" before it spreads and becomes chronic.

Within the eurozone, large external imbalances have been allowed to emerge over the last decade. The competitive position of peripheral countries deteriorated sharply vis-à-vis the eurozone’s core countries, but their governments ignored all the warnings and turned a blind eye to the accumulation of credit-fuelled bubbles and public or private debt. They also failed to take anti-cyclical fiscal measures or to promote structural reforms. Their large external deficits were matched by surpluses in Germany and other core economies, and the persistence of these imbalances led to the transfer of excess savings to the periphery, creating the conditions for extensive borrowing – particularly in high-inflation countries on account of the “one size fits all” euro interest rate – in both the private and public sectors.

In fiscally responsible countries like Spain, excess savings resources were borrowed by the private sector and were often invested in what later became bubbles – housing assets. The bursting of these bubbles created insolvency problems for banks, while the bubble-induced recession coupled with the disruption produced by the financial crash and the associated collapse of exports led to an explosion of budget deficits and so to full-blown fiscal crises.